Mankiw’s Philosophical Case Against Taxing Capital Income

Isaac Chotiner provided a wonderful rebuttal to something Greg Mankiw write about minimum wages and Obamacare. For me – the takeaway line was:

Notice that Mankiw first claims there is no way to compare people's happiness, and then he goes ahead and...makes a comparison, just in the opposite direction.

The reason this is my takeaway line as that Mankiw is at it again with a criticism of something Paul Krugman wrote. Up first – Paul:

most people realize that today’s G.O.P. favors the interests of the rich over those of ordinary families. I suspect, however, that fewer people realize the extent to which the party favors returns on wealth over wages and salaries. And the dominance of income from capital, which can be inherited, over wages — the dominance of wealth over work — is what patrimonial capitalism is all about. To see what I’m talking about, start with actual policies and policy proposals. It’s generally understood that George W. Bush did all he could to cut taxes on the very affluent, that the middle-class cuts he included were essentially political loss leaders. It’s less well understood that the biggest breaks went not to people paid high salaries but to coupon-clippers and heirs to large estates. True, the top tax bracket on earned income fell from 39.6 to 35 percent. But the top rate on dividends fell from 39.6 percent (because they were taxed as ordinary income) to 15 percent — and the estate tax was completely eliminated.

Greg’s only rebuttal was to present the literature on the alleged optimality of not taxing capital income. The argument simply put is that not taxing capital income is one way to encourage savings and a higher level of steady state output per capita. Of course, this simple argument known since Frank Ramsey made it in 1927 ignores several things including the fact that current generations must by definition consume less. It also ignores the distributional effects that Paul was stressing. The biggest omission, however, was the fact the Bush’s fiscal policies in general actually reduced national savings through what some would argue was reckless fiscal policy. Of course, Greg Mankiw tried to defend this fiscal stimulus by saying it was necessary to head off a recession – or something like that. But hey - we do know that Bush's fiscal policy made very rich people better off and as Isaac notes, Greg loves rich people.